Maybe the Fed will burst a few bubbles

Page Tools

The US media has made much of the fact that the new chairman of
the US Federal Reserve, Ben Bernanke, likes to dress as casually as
he can.

In sharp contrast to the dour formality of his predecessor, Alan
Greenspan, Bernanke has jokingly proposed that the top officers in
the world's most important central bank should wear Hawaiian shirts
and bermuda shorts.

An obvious difference is that Bernanke, at 51 is a generation
younger than Greenspan, who will retire in January at the age of
79. But there are much more important distinctions between the two
men.

Bernanke has a different view from Greenspan on the two main
policy matters that confront the American central bank.

One involves the struggle against inflation. The other is how to
deal with a problem confronting authorities all around the world,
and threw the US economy into recession in 2001 - what to do about
the bubbles.

On inflation, Bernanke has long advocated that the Federal
Reserve adopt a formal, publicly declared target for inflation, a
fashion that New Zealand started and Australia and other countries
followed.

Greenspan has always resisted. The Fed has not had a problem
with its inflation performance, he argues, so "if it ain't broke,
don't fix it". His core objection, however, is that a formal target
would rob him of the freedom to act as he sees fit.

Many Fed watchers expect Bernanke will introduce a formal
inflation target for the Fed of 2 per cent, plus or minus a
percentage point.

But this is a distinction without a difference. Academics
concluded years ago that the Greenspan Fed has been aiming for
inflation of 1.8 per cent.

Greenspan summarised a closed-door discussion on the subject
inside the Fed in 1996 by saying: "We have now all agreed on 2 per
cent."

In any case, inflation is a war-weary enemy that no longer puts
up a spirited resistance. It is a familiar problem with a
well-tested cure. US inflation peaked in 1982. And though it is not
dead, it has long been quiescent.

The real challenge is what to do about the other type of
inflation - inflation in asset prices, especially stocks and real
estate. When these prices soar above their fundamental value, they
create "bubbles".

It was a bursting bubble that plunged the world's second-biggest
economy, Japan, into a decade-long funk; and it was a bursting
bubble that threw the biggest, America, into its recession in
2001.

These experiences convinced many of the world's central banks
that they should take bubbles into account in the way they set
policy. But Greenspan, in defending his own record, has since
argued against acting on bubbles.

The irony is that while the rest of the world learnt from
America's experience, the US itself did not. It was a turning point
in the understanding of how central banks should run economies, and
the US, to date, has missed the turn.

Bernanke, however, appears to have a more open mind. Like
Greenspan he does not favour using interest rates to try to contain
bubbles, but he has said that there may be a case for using the
Fed's regulatory powers over the banks and markets to constrain a
dangerous bubble. He is prepared to think about it. And this is
progress.

Page Tools

SPONSORED LINKS

More news

1130239521908-smh.com.auhttp://www.smh.com.au/news/world/maybe-the-fed-will-burst-a-few-bubbles/2005/10/25/1130239521908.htmlsmh.com.auSydney Morning Herald2005-10-26Maybe the Fed will burst a few bubblesPeter Hartcher International EditorWorld